The RSM Brexit Stress Index surged on Wednesday, following news that the government of Prime Minister Boris Johnson had received the okay to suspend Parliament just weeks ahead of a deadline for the U.K. to chart its path for withdrawal from the European Union.
The composite index, which measures economic stress surrounding Britain’s impending departure from the EU, closed at 1.85 on Wednesday, up nearly 10 points from last Friday’s close at 1.76. Johnson’s ability to suspend Parliament ahead of Britain’s Oct. 31 Brexit deadline signals the likelihood that his “no-deal” Brexit will proceed, as it gives members of Parliament less time to block it.
The index—which reflects significant stress in the bond market—has now reached levels associated with the 2016 Brexit referendum and the rejection of the Prime Minister Theresa May’s EU deal. Higher levels of financial market stress are associated with pullbacks in lending and borrowing practices and portend slower economic growth in coming quarters.
The week’s political gyrations and the polite attempts at diplomacy left the bond market cold, with the 10-year gilt yield dropping to 0.44%, while the 30-year gilt made an unprecedented move below 1.0%. The 10-year/three-month yield curve is now inverted by 32 basis points; that hasn’t happened since the financial crisis and subsequent recession of a decade ago. In short, the bond market is anticipating slow growth in the years ahead.
The EU appears to have confirmed its commitment to an orderly withdrawal agreement as the Oct. 31 deadline approaches, while the U.K. government seems to be ignoring what the bond market is bracing for, which might explain 30-year gilts falling below 1.0% yields.
Performance of index components
The RSM Brexit Stress Index is made up of six components; they include the British pound-euro exchange rate and its volatility, the FTSE 100 and its volatility, the gilt yield spread and the U.K. corporate bond spread.
The pound recovered 0.4% of its value versus the euro, and 0.3% against a basket of its trading partners amid increased volatility. This is the third week in a row that the pound has benefited from the market’s concern over Germany’s manufacturing slump and the impact of U.S. trade policy on the global economy.
The FTSE 100 recovered 0.3% of the prior week’s losses on slightly lower volatility.
The yield on 10-year gilts decreased by four basis points, reaching 0.44% at the close on Wednesday. As noted above, the 10-year/three-month yield curve is inverted by 32 basis points on concerns over the direction of U.K. and global growth.
Corporate spreads widened, but just a bit as the bond market maintained its assessment of risk.
